The Financial Stability Board (FSB) published a progress report on the implementation of recommendations of the 2014 Reforming Major Interest Rate Benchmark report. The FSB observed that there is good progress in the derivatives and securities markets, however, transition in lending markets has been slower. The report further outlines the progress on the implementation of the recommendations. Firms are expected to increase scrutiny of their transition efforts, given the degree of risk arising from the continued reliance on LIBOR. To mitigate risk of discontinuations of LIBOR, it is also crucial for regulated firms to ensure contractual fall-back provisions are sufficiently robust.
KPMG Insight: The FSB is actively monitoring the progress of implementing recommendations from the 2014 report. Furthermore, other regulators also keep an eye on progress of LIBOR cessation. The FCA encouraged financial instructions to recognise the possibility of a non-representative LIBOR being published for a period of time prior to final cessation. IBA also published a letter on 24 January 2020 introducing its Changes and Cessation Procedure which outlines the steps that IBA would take in case LIBOR settings become non-representative. Banks in Hong Kong should be prepared that HKMA may also issue more guidance to the market participants.
18 December 2019 FSB
2. FINRA Risk Monitoring and Examination Priorities Letter for 2020
The Financial Industry Regulatory Authority (“FINRA”) published 2020 Risk Monitoring and Examination Priorities Letter and identified several focus areas for 2020. In particular, the FINRA will focus on firms’ exposure to LIBOR-linked financial products, plans for the transition away from LIBOR, and the impact of LIBOR phase-out on customers by engaging with firms to understand progress made to date.
KPMG Insight: Firms should continue to focus efforts on the transition and consider designing and updating relevant controls, policies and procedures to ensure compliance with the transition from LIBOR to risk-free rates.
9 January 2020 FINRA
3. FCA and BOE joint letter on the next steps for LIBOR transition
On 16 January 2020, the Financial Conduct Authority (“FCA”) and the Bank of England (BoE) made an announcement highlighting that, although several important milestones were met in 2019, greater momentum is required with 2020 being the key year for transition. The published joint letter outlines key targets set by the Working Group on Sterling Risk Free Reference Rates (“RFRWG”), which include shifting from LIBOR to SONIA in derivative markets, ceasing issuance of cash products linked to sterling LIBOR maturing beyond 2021 by end-Q3 2020, and reducing the number of contracts referencing LIBOR by Q1 2021. The FCA will perform ongoing assessments on firms’ LIBOR transition progress by collecting data, reviewing management information, and through regular supervisory relationships.
KPMG Insight: As part of planning for the LIBOR transition, firms should ensure they have incorporated the following key areas in their plans for Q1 2020: product development, review of infrastructure (including updates to loan system capabilities), client outreach, and updates to relevant documentation, i.e. policies and procedures. Firms should monitor progress in these areas as they will be a key input to the FPC’s consideration in mid-2020 to avoid seeking recourse to supervisory tools.
16 January 2020 FCA
4. Use Cases of Benchmark Rates: Compounded in Arrears, Term Rate and Further Alternatives
The RFRWG published a paper to provide guidance on potential usage of Term SONIA Reference Rates and explain why transition to SONIA compounded in arrears is preferred for most types of new business. The development of a Term SONIA Reference Rate is progressing well. The FTSE Russell, ICE Benchmark Administration, Refinitiv, and IHS Markit confirmed they are working on the development of a Term SONIA Reference Rates, though different methodologies have been adopted by these administrators. The RFRWG believes that use of SONIA compounded in arrears is appropriate and is likely operationally achievable for approximately 90% of new loan deals by value.
KPMG Insight: The RFRWG has been recommending the SONIA benchmark as the preferred reference rate since 2017 and set a target to cease issuance of GBP LIBOR-based cash products by the end of Q3 2021. It is expected that the RFRWG will provide more guidance in addressing barriers to LIBOR transition.
16 January 2020 RFRWG
5. Request for Assurance of Preparedness for LIBOR Transition
The New York State Department of Financial Services (“NYDFS”) extended the deadline for regulated entities to submit their plans for handling the end of LIBOR and the associated risks. The deadline was extended from 7 February 2020 to 23 March 2020. The regulated entities are asset managers, which include FCA authorised firms that predominantly directly manage or advise on mainstream investment vehicles, excluding wealth managers and financial advisers, and FCA authorised firms that manage or advise on alternative investment vehicles. The NYDFS granted this extension in response to “numerous requests”.
KPMG Insight: The year of 2020 is expected to entail regulators and industry-wide bodies issuing more surveys globally to firms to ascertain the progress and identify issues (if any) in their transition away from LIBOR.
23 January 2020 NYDFS
6. LIBOR Reform and its Effects on Financial Reporting
On the 30th January 2020 the International Accounting Standards Board (“IASB”) met to discuss the potential effect of LIBOR reform on IFRS standards and the potential disclosure requirements. As part of the discussions, it was concluded that only some accounting standards examined would need to be revised as an impact of LIBOR reform.
KPMG Insight: The IASB also published the “Interest Rate Benchmark Reform (Amendments to IFRS 9, IAS 39 and IFRS 7)” in September 2019. The amendments provided guidance on uncertainty arising from the LIBOR phase-out. Firms should also take into consideration revision of accounting standards other than those related to financial instrument accounting and their impact on financial reporting.
30 January 2020 IASB
1. Interest Rate Benchmarks Review: Full Year 2019 and Fourth Quarter of 2019
A recently published paper by the International Swaps and Derivatives Association (“ISDA”) provides a review of Interest Rate Benchmarks Review. ISDA performed analysis on trading volumes of interest rate derivatives transactions in the U.S. referencing the Secured Overnight Financing Rate (“SOFR”) and other alternative risk-free rates, including the Sterling Overnight Index Average (“SONIA”), the Swiss Average Rate Overnight (“SARON”), the Tokyo Overnight Average Rate (“TONAR”), and the Euro Short-Term Rate (“€STR”).
KPMG Insight: The increase in SOFR and SONIA-referenced trading volumes is expected given their familiarity across market participants and the already established liquidity infrastructure. It is urgent for financial institutions to identify appropriate alternative risk-free rates and prepare a comprehensive transition plan.
21 January 2020 ISDA
2. ARRC Releases Consultation on Potential Spread Adjustment Methodologies
On 21 January 2020, the Alternative Reference Rates Committee (“ARRC”) sought public feedback on the methodology for calculating spread adjustments for cash products referencing U.S. dollar (USD) LIBOR. Target respondents included, but were not limited to, cash market participants in floating rate notes, syndicated loans, business loans, securitizations, and retail consumer products referencing LIBOR. The ARRC aims to recommend a static spread adjustment and make the spread-adjusted rate comparable to LIBOR by minimizing the expected change in the value of financial contracts arising from the move to a replacement benchmark based on SOFR.
KPMG Insight: Market participants should make their own evaluation in considering whether to implement or adopt the suggested contract language outlined in the ARRC’s consultation paper. The ARRC recommended spread adjustments are for LIBOR contracts which incorporate the ARRC fallback language, or for legacy LIBOR contracts where parties are able to select ARRC-recommended spread-adjusted rates as a fallback. The ARRC notes that the methodology used to determine the spread adjustments for consumer products may differ from the methodologies used for other cash products. In addition, market participants should take into consideration the various methodologies for determining the spread adjustment outlined by AARC and provide feedback on the consultation paper by March 6, 2020 regarding appropriate methodologies for spread adjustment.
21 January 2020 ARRC
3. Recommendations for Interdealer Cross-Currency Swap Market Conventions
The ARRC published recommendations for interdealer cross-currency basis swaps that use SOFR and overnight RFRs recommended by ARRC and other similar National Working Groups. The paper focuses on dealer-to-dealer transitions and consists of three sections. The first section covers potential conventions for overnight RFR-RFR dealer-to-dealer cross currency basis swaps. The second section covers potential conventions for RFR-IBOR dealer-to-dealer cross currency basis swaps. The last section covers potential fall-backs for cross-currency swaps currently referencing IBORs.
KPMG Insight: The paper provides guidance on formulating structures for cross-currency swaps that use SOFR and other RFRs. It is also worth noting that ISDA is considering the establishment of a template that would facilitate the transition of both legs of a legacy cross-currency swap referencing IBORs to successor rates.
24 January 2020 ARRC
4. ARRC Releases Vendor Survey and Buy-Side Checklist on Transition to SOFR
The AARC published a vendor survey and buy-side checklist to support financial institutions to address operational challenges in transitioning to SOFR. The vendor survey helps software and technology vendors assess their own readiness. There are two sections in the survey, the first covering fundamental questions about the transition, and the second covering high level capabilities required for LIBOR transition. The buy-side checklist provides guidance for buy-side firms in the practical adoption of SOFR.
KPMG Insight: Financial institutions should begin to plan for the implications across program governance, valuations, product strategy, risk management, systems and accounting. APAC buy-side firms have generally been slower than the US/UK/EU and should use this checklist to accelerate transition preparations.
31 January 2020 ARRC
Financial Risk Management
Partner, Head of Financial
Financial Risk Management